Last week turned out to be quite a significant one in several respects. We saw for the first time a euro zone country in such a state of distress that she had to ask for help. The Greek Prime Minister Mr. Papandreou gave a dignified speech but the cry of “help” will have resonated around the world. It will have reminded everyone that the constitution of the Euro had two rather large flaws namely that it was constructed with neither political union nor co-ordination of fiscal policy.Indeed the planners of Europe had made grand claims for economic convergence whereas in fact we have had economic divergence. In that sense it is hard to think of a scenario which would have proved them more in error.
The week was also significant for the International Monetary Fund which finds itself thrust into the firing zone of European Union politics. As I have written before it is used to having primacy and control when it intervenes to help a country which is in crisis. I have also previously pointed out that its original role was to help countries with balance of payments problems. Now whilst Greece does have a balance of payments problem her real problem is a fiscal deficit so the role of the IMF is morphing from its original objective to become a type of fiscal deficit policeman. No wonder the G20 authorised a US $ 500 billion increase in the loan capital of the IMF which came into effect on April 12th this year. So the IMF has in effect a new role and expanded capital to do it but in this instance she also has to deal with the European Central Bank and the European Commission. So this issue is a big challenge for the IMF and its role.
There is one further ingredient to the mix. The President of the IMF Mr. Strauss-Kahn is widely believed to have political ambitions in France probably for the Socialist Party there. So it is not inconceivable that he will try to meddle with the plans of IMF negotiators and officials for Greece. It would certainly suit him to have a “success” , so a scenario which has suffered from political meddling may well get another dose of it.
A Question for you
I have a question for my readers here and it relates to the recent increase in loan capital for the IMF. This was announced to great fanfare at the April 2009 G20 meeting by the UK Prime Minister Gordon Brown. He announced it as if it was a rabbit from a hat. However there are potential implication from it, for example what would happen if some of the money was lent and the loan was not repaid? Who is then liable? Has there in any country been a debate on this? As the largest player the biggest potential burden is on the taxpayers of the United States but all G20 countries are involved and liable. This strikes me as an off-balance sheet liability for the taxpayers of the G20 nations.
Before this capital increase which came into effect various nations made bilateral loans.We in the UK had a bilateral agreement to loan $15 billion if necessary since last September as a lead into this. I read the agreement and noticed that it was set up as a recurring one year deal which immediately triggered a thought at the back of my mind that such a term might be sufficient to stop it going into the national accounts. This leaves me with the view that this latest more formal increase in loan capital may not have a corresponding debit anywhere in the world’s accounts…….
There is a lot of debate going on in Greece as to what is the best course of action will be. There is clearly fear in the air as to what terms may be imposed by the IMF on her. Indeed even the man who called for aid her Prime Minister said that Greece would now see “a partial surrender of sovereignty”. However the truth is that she had no choice as she had lost any semblance of control over her debt markets and it would have been much better if she had made the decision earlier when yields were lower. Whilst I have sympathy for the situation the current government found itself in I have much less sympathy for the way that her government has dithered and vacillated. However I have no sympathy at all for the opposition New Democracy Party the previous Greek government which has had the cheek to accuse the current government of creating the crisis. This is a shameful effort to rewrite history and avoid the implications of ita own actions.
On Friday Greece’s ten-year bond yield closed at 8.73% and remember this was after an announcement of officially calling for aid. This time the rally from an official announcement lasted about 3 hours at most and the story of the boy who cried wolf comes to mind when I think of the number of times politicians have claimed to have “saved” her. She has a three-year bond which closed at 10.64% and I quote this because I suspect this yield might be quoted in the German Constitutional Court as time goes by, as the proposed loans at 5% from Europe will have a three-year term and will be at a rate at less than half of market rates when the aid plan was called for.
What is happening right now?
Leaks from the negotiations are suggesting that the European Commission is taking the lead (IMF primacy anyone?) and it is marching to a German inspired tune. This would involve an austerity plan for next year equivalent to the one already imposed by the current Greek government for this year. So Greece must come up with a detailed programme for cutting the budget next year by a further 4 % of her gross domestic product (GDP).Let nobody be in any doubt that if you look at historical comparison this will be a severe squeeze.
Whilst Mr. Strauss-Kahn may be pleased at avoiding being a public bogeyman for the sake of his future political ambitions this is not a good development as the IMF should be in charge. Also whilst it is a good sign that 2011 and hopefully 2012 are being addressed in some form the aid package will have to include money for those years too and at this time it does not. Greece will have to borrow heavily in 2011 and 2012 and if it is to work this aid package will have to have the ability to cover these years too.
What needs to happen?
1. The potential size of the loans available to Greece need to be substantially increased. The current amount is not enough and I would treble it as Greece will need help in 2011 and 2012. I would hope that it would not need to be fully used and that circumstances might improve but now is a time for a contingency fund that covers pretty much anything and everything. Because of the dithering that has gone on we now need a decisive move to try to retake the initiative.
2. Greece needs to present a three-year programme that involves a combination of specified expenditure cuts and also plans for structural reform. In essence the objective needs to change to attempting to achieve a balanced budget by the end of the three-year term so that Greece can then finance herself.
3. European and Greek politicians have so far disappointed and they have made a difficult situation worse. They need to realise that this is a national emergency and get a grip on both events and reality.
4. Greece should begin now negotiations for a technical default or “haircut” on her existing debts. I have argued previously for a 15% haircut but because of the deteriorating situation I feel that this now needs to be 20%.
This adjustment will be painful and there is no guarantee of success as there is a danger of a downward spiral where recession leads to depression for Greece. Whilst there are differences in the situation between Greece and Latvia those interested in the scale of the likely impact on Greece might like to look at my update of the 12th March.